The US Federal Reserve decided to increase interest rates by a quarter percentage point last week. South Korea, however, unexpectedly cut its key interest rate by the same margin simultaneously. It seemed as if Seoul did not care about its problem with inflation, which surged 4.4 percent last month.
What kind of game is Seoul playing?
To explain this, we need to look at the drivers behind South Korea's economic growth in recent years. Before the 1997 Asian financial crisis, the Korean economy was mainly fueled by investment. The financial storm proved that a lot of the investment was unnecessary or redundant. After the crisis, given to the country's openness to foreign investment and a low exchange rate, foreign investment and exports continued to support the country's economy to a certain degree.
Since then, however, in view of the volatile nature of foreign investment and exports, the Korean government has gone all out to stimulate domestic spending. It provides vendors with preferential treatment, subsidies and even staff recruited from alternative military service. It also encourages taxpayers to pay taxes by credit card to enjoy a tax discount.
These measures of course have their limitations. That is why the Korean economy experienced a slowdown last year with growth falling behind the other three Asian Tigers its worst performance in recent years.
Economic growth finally bounced back to 5.3 percent in the first quarter this year. Yet global stagnation and recent oil hikes may affect its export growth recovery. As well, many banks are also suffering from the problems of non-performing loans due to excess credit card use.
Some inferred that the motive behind Korea's interest rate cut is to expand domestic credit and prevent non-performing debt from worsening. But such a decision will only exacerbate the situation. The Bank of Korea would not have cut rates for this reason.
Others suggest that Korea may be attempting to compensate for reduced competitiveness given higher international oil prices.
Still others believe Korea is trying to create room for depreciation. If this is the case, then it is playing a dangerous game, in which Korea is the player and other countries have assumed the risk.
If everyone decides to play this dangerous depreciation game, all will suffer, big time. But if we do not play along, Korea will be the sole beneficiary while other countries suffer small losses. If this really happens, Taiwan's economy would suffer the most.
Although Korea's decision to lower interest rates was not aimed at harming Taiwan's enterprises, Taiwan's semiconductor and display industries will be hit hard by the move. And these two industries represent the "two trillion" industries in the government's "Two trillion, twin star" (
Over the past year Asian countries, despite possessing extensive foreign exchange reserves, have been reluctant to allow their currencies to appreciate. They fear that a strong currency would reduce export competitiveness. But the price they may pay for this policy is inflation.
Many countries are now adopting measures to alleviate inflation, while one country is insisting on moving in the opposite direction. Taiwan unfortunately will be the first to bear the brunt of such a decision. What should we do? Whether other countries will intervene to stop this depreciation competition or not, we need to figure out our strategy first.
Kung Ming-hsin is a research director at the Taiwan Institute of Economic Research.
Translated by Jennie Shih
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